The Dollar/Oil/Inflation Revolving Door

The big thing to realize when it comes to comparing these three, is that when one moves the others will move as well.  There is really no way to explain one without going into detail about how they affect one another.  The perceived driving force behind all of this is commodities.

The commodities market includes trading everything from cotton and orange juice to corn and gold, but is ruled by those investors who are placing bets on where they think oil prices are going next. Prices of the most valuable commodity in the world tend to primarily change based on supply and demand factors, geo-political concerns, and most importantly for this article, the value of the U.S. dollar. With crude oil denominated in U.S. Dollars across the world, there is a clear negative correlation between oil prices and the value of the Dollar. Even before the oil is pulled from the ground, it has immense power that can easily influence the world’s currency markets. When countries go to the commodities markets and try and sell their oil, the purchaser must buy the oil with U.S. Dollars. If you have U.S. Dollar reserves to make the purchase then great, but if you don’t then you head to the forex and change your money, Euros for example, into Dollars. This is where the Euro/Dollar relationship takes flight. Over beginning of the 21^st century, the dollar depreciated against the Euro largely due to high supply of Dollars and low demand. This meant that as oil prices began to rise, it would have been wise for countries to keep their oil reserve money in Euros instead of Dollars, even though they needed to pay in Dollars. This can be understood by simply looking at the exchange rate between the Euro and the Dollar over the last ten years. As the USD gradually depreciated against the Euro and oil became nominally more expensive across the board, if you were buying oil strictly with Dollars, you would be paying a much higher real rate then if you had Euros and exchanged them for Dollars to buy the oil.

One way to combat currency exchange risk is to hold assets in the countries where you are planning on buying oil from because you will hedge yourself against future currency changes. For example, if the United States planned on buying oil from Australia in five years but was worried that their currency might appreciate against the USD, then the U.S.